With an improving economy and an accelerating job market, the prospect of interest rates hike is moving closer despite global growth concerns. The Fed indicated its confidence in the economy in the latest FOMC meeting and confirmed that it is on track to raise the interest rates for the first time since 2006, sometime later this year (read: Top and Flop ETFs Post Fed Meeting).
In fact, Atlanta Fed President Dennis Lockhart yesterday stated that the interest rates hike could come as early as next month.
This is especially true given that the first-quarter slump in the U.S. seems to have been tided over with 2.3% economic expansion in the second quarter. The economy created at least 200,000 jobs in 13 of the past 15 months with broad-based gains and unemployment dropping to the seven-year low of 5.3%. Further, economic activity has been rising moderately, consumer confidence and spending has increased, and the housing market is seeing frenzied demand for homes.
While the overall economy is gaining momentum lately, subdued inflation, lower business investments, and soft exports continue to weigh on economic growth. As such, uncertainty still looms around the timing of interest rates. The Fed also indicated that the path of rate hikes would be gradual, meaning that the Fed will take baby steps once embarks on the trail of increases.
Given this, investors should be well prepared to protect themselves from higher rates albeit at a slower pace. Here are number of strategies that could prove extremely beneficial for ETF investors in the rising rate environment:
Financial Sector Remains a Hot Spot
A rising interest rate scenario would be highly profitable for the financial sector. This is because the steepening yield curve would bolster profits for banks, insurance companies and discount brokerage firms. A broad way to play this trend is with Financial Select Sector SPDR Fund (XLF – ETF report), which has a Zacks ETF Rank of 1 or a ‘Strong Buy' rating (read: Top Ranked Financial ETFs in Focus on Improved Outlook).
Other top-ranked funds targeting the niche segment of the broad financial sector are SPDR S&P Regional Banking ETF (KRE – ETF report), SPDR S&P Bank ETF (KBE – ETF report) and PowerShares KBW Capital Markets Portfolio ETF (BKLN). These funds have a Zacks ETF Rank of 2 or ‘Buy' rating.
Hedge with Niche Bond ETFs
Though the fixed income world is the worst hit by the rising rates scenario, a number of ETFs that employ some niche strategies like PowerShares Senior Loan ETF (BKLN – ETF report), iShares Floating Rate Note ETF (FLOT – ETF report) and iPath US Treasury Steepener ETN (STPP – ETF report) could lead to huge gains. This is because the senior loan funds are floating rate instruments and thus pay a spread over the benchmark rate like LIBOR, which help in eliminating interest rate risk (read: Hedge Rising Rates with Floating Rate ETFs).
